Mahanagar Gas: Strong Q2 show instils confidence

Good outlook on long-term sales and sound financials to help stock sustain its premium valuation

Fuel distributor Mahanagar Gas Limited (MGL)'s better-than-expected results for the September quarter (Q2) have further strengthened confidence in the company's growth story. For the quarter, the strong expansion in operating profit margin more than offset lower growth in sales volumes. As a result, the company posted a 41 per cent year-over-year increase in net profit to Rs 102 crore, ahead of Bloomberg consensus estimate of Rs 95 crore. Falling costs of natural gas (MGL's key input) along with savings on expenses, and the fact that the company did not fully pass on the cost savings to customers, led to an 881-basis-point surge in operating profit margin to 31 per cent. A lower tax rate further aided net profit in the quarter. 

Though sales volume growth of 4.8 per cent was lower compared to 7.5 per cent in June quarter, part of the weakness was due to the high base of September 2015 quarter, when compressed natural gas (CNG) sales volumes grew at a robust pace. However, even as MGL's revenues fell 3.4 per cent to Rs 521 crore, those beat Street estimate of Rs 498 crore. CNG adoption in vehicles continued at the pace seen in recent quarters. Piped natural gas (PNG) sales volumes, however, grew a healthy 7.2 per cent in September quarter. MGL plans to start gas supply to Raigad (Maharashtra) by March.

The company also stands to gain from regulatory push to more environment-friendly fuels such as CNG as well as expansion into new cities. Not surprisingly, most analysts remain positive on MGL. Strong return ratios and financials are other reasons investors like city gas distribution (CGD) players such as MGL.

Mahanagar

A few analysts, however, are concerned about any increase in competition from oil marketing companies. "OMCs operate a significant portion of CNG stations for players such as MGL and any increase in competition from them may lead to loss of customers or threaten operating profit margin in the medium term," says Tarun Lakhotia, analyst at Kotak Institutional Equities. Indian Oil Corp's comments on draft rules for CGD rates indicate it is keen on CGD marketing business, he adds. While MGL remains confident about facing off against rivals, the Street will keep an eye out.

In the near term, MGL could witness some impact of note ban on its sales volumes. While PNG remains a more stable revenue stream, CNG sales volumes could come under pressure this quarter, say analysts. 

Now, MGL's market value is 19 times its FY17 estimated net profit, and the stock seems to be pricing in the positives. Long-term investors could use share fall to buy the stock.